Wal-Mart has muscled its way into the food business.
Now competitors are scrambling to keep up. Brian O'Keefe Mon May 13, 2002 Fortune Magazine

To say that Kimberly Rutkowski is an organized grocery
shopper is to seriously understate the case. Rutkowski and her husband,
Sean, livewith their daughter,
Ashley, 5, and son, Tyler, 2, in a modest,two-story pink brick house in the fast-growing Dallas
suburb ofRockwall. Every Sunday
morning the 32-year-old working mother goesthrough the paper, clips coupons for products she likes, and
thentransfers them to a gray plastic box labeled
kimberly's coupons. Whenshe's
through, she begins planning her family's dinner menu for thecoming week--cheesy chicken casserole on Monday
perhaps, pancakesevery Thursday--and
makes a list of what she'll need. She thencrosschecks that with a list of about 100 of
her family's staples,sorted
by category, which she has organized into an Excel spreadsheet. By early
afternoon she is ready to climb into her Dodge Caravan minivan and hit
the aisles.

She doesn't have to go far. Area developers have made
sure the folks who inhabit the rapidly expanding suburban Dallas
enclaves will notwant for retail
options, especially when it comes to groceries.Dallas, in fact,
is probably the most cutthroat, overstored market inthe country. At a single intersection half a mile from Rutkowski'shouse, Super 1 Foods and Albertson's grocery
stores face off against a brand-new Tom Thumb. But virtually every time
this expert shopper heads out, she drives by all three, continuing the
extra two miles tobuy the bulk
of her groceries at the new Wal-Mart supercenter inRowlett. Rutkowski, who spends $150 to $200 each weekend on groceries,
figures that she saves about $50 this way. That has made her a loyal
Wal-Mart shopper--despite some bad experiences with less-than-freshdairy products and pushy customers. "The kind of crowd that
Wal-Martbrings in can be a little
scary, but I guess I'm one of them," saysRutkowski with a laugh. "If I had a choice, I'd go somewhere
else."But for the price-conscious,
there really is nowhere else to go: Thediscounter saves food shoppers like Rutkowski an eye-popping
30%, onaverage, on their weekly
grocery bills.

That kind of pocketbook appeal is helping Wal-Mart,
the world's largest retailer, take on a new title: your neighborhood
grocer. Thechain that Sam Walton
built by stacking up discount clothes andfishing gear rang up $56 billion in grocery sales last year,
making it the nation's No. 1 food retailer. While Wal-Mart had less
than 6% of the grocery market in 1995, Bear Stearns estimates it now
commands animpressive 10.3%
share--a figure that could rise to 15% as early as 2004. And that doesn't
even count the food sold at its network ofSam's Club wholesale stores. Wal-Mart's resounding
success sellinggroceries is
sending shock waves through a staid industry, forcing out smaller players
and driving stronger ones to bulk up or face the same fate. And it won't
get any easier for the competition. Says UBSWarburg grocery analyst Neil Currie: "The whole value-for-moneyequation is forever shifting toward Wal-Mart."

To think that, less than a decade ago, Wal-Mart had
barely gotten its start in the food business. Sam Walton's discount
chain tinkered withthe idea
of groceries for years, first borrowing the concept of thesupercenter--180,000-square-foot units that incorporate a full-sizedgrocery store inside a regular discount store--from the European"hypermarket" in the late 1980s. But it wasn't until
the mid-1990s,after Walton's
death, that then-CEO David Glass decided to stake thecompany's growth on its ability to sell meat and potatoes in
anexpanding network of supercenters. The rationale
was simple--traffic.Whereas
the average shopper might come to Wal-Mart only once or twicea month, people buy groceries, on average, more
than twice a week.Glass also
looked at the grocery business and saw an industry threetimes as big as discount retail, but highly
splintered and lacking aheavyweight
that could match the Arkansas
company's famed logisticsand
distribution capabilities. In short, Wal-Mart's management lookedat the food business and didn't see a Wal-Mart.

It hasn't looked back. Since 1996 the number of supercenters
has jumped from 260 to 1,060, and the company will probably double that
in the next four years. Grocery sales at Wal-Mart's supercenters are
growing twice as fast as its overall business. Not only that, but thecompany is ramping up its food distribution
network. UBS Warburg'sCurrie
predicts that the company could support as many as 4,000supercenters across the country by 2006. Wal-Mart, for its part,
won't

project the growth of its grocery business
beyond this year. "We just don't talk much about our food business
publicly," says spokesman JayAllen.
(The company declined to make a member of management availablefor this story.) The enormous supercenters remain
the cornerstone ofits strategy,
but Wal-Mart is also tinkering with smaller-sizedsupercenters and even cozier grocery-only Neighborhood
Market stores.These are designed
for metro areas, where supermarkets typicallydominate. CFO Tom Schoewe told shareholders
at last year's annualmeeting
that the company is still refining the strategy. "Then you'llsee our foot pushed on the accelerator,"
he boasted.

Wal-Mart investors didn't always find groceries so
appealing. The combination of entrenched competition and low margins
seemed like aprofit-killer.
In truth, grocery store margins drifted upward duringthe past decade, as retailers jacked up prices faster than their
costs increased. That rise gave Wal-Mart a perfect way to crack the
business. If supermarkets make a penny of profit for every dollar ofgrocery sales (the common statistic cited by the industry), Wal-Martwas willing to make do with far less. Supermarkets work with
grossmargins of around 24%,
whereas Wal-Mart will reportedly go as low as16%. It's all part of a bigger strategy. Wal-Mart knows that
moms whocome in to buy, say,
eggs and Lean Cuisine often wander over to buyhigher-margin stuff on impulse, like lamps or,
in the case of KimberlyRutkowski, plastic organizers. The more regular
shoppers the company cultivates, the easier it is to drop prices even
further. That's whyon a recent
afternoon Rutkowski could buy Jif peanut butter, Kellogg's corn flakes,
Ragu spaghetti sauce, and a gallon of milk for just $8.61 at Wal-Mart--stuff
that would have cost her $11.66 at Safeway-owned Tom Thumb.

Such a yawning price gap is leaving Wal-Mart's major
competitors with two choices: get big or get gone. The need to scale
up has led to the emergence of a few national players--the Big Three
of Kroger, Albertson's, andSafeway--that
are aggressively snapping up smaller players to keep pace with Wal-Mart.
For the little guys, being bought is often the best they can hope for.
Indeed, Kroger CEO Joseph Pichler says that 1,800 grocery stores or
pharmacies have been either shuttered or acquired in the past 22 months
alone, at least partly because of the supercenter effect. In addition
to Wal-Mart, other discounters like Target are getting into the grocery
game and vying for their share. Walgreen has even started adding fresh
produce in many of its drugstores.

Not surprisingly, traditional grocers are studying
Wal-Mart more closely than ever. In December, Kroger, the biggest of
the Big Three,with $50 billion in sales in its 2,400 stores
last year, announced asweeping
plan to streamline management, centralize its buyingprocedures, and plow profits back into prices--in short, to be
morelike Wal-Mart. That's harder than it sounds.
Pichler says the companyhas
only recently developed the kind of technology necessary to stockand manage its stores nationally, rather than
regionally. "We'velearned
some things from Wal-Mart, no doubt about it," he says.

Mainly what they've learned is that to survive they
must compete on price, says Henry Vogel, a pricing expert at Boston
Consulting Group.In the past
few years the grocery chains have developed shopping cards for regular
customers. They allow the companies to track individual buying habits,
giving shoppers special discounts in return. In thepast six months each of the Big Three has announced that it will
bereducing the disparity between
its own prices and Wal-Mart's. That'seasier said than done--the gap averages as much
as 30% beforediscounts and coupons.
To do so, Kroger announced in December thatit's chopping $500 million from its operating costs. Albertson's
hasthe same goal. It's a major
effort--and it still may leave them at acompetitive disadvantage. "I think some of them have their
heads inthe sand about the impact
of Wal-Mart in the future," says UBSWarburg's Currie. "I just worry that it's a little too late,
and notenough."

That's not to say that price is the only way to counter
Wal-Mart. Possibly the most distinctive store in Dallas
is the new CentralMarket, a
gourmet superstore recently opened by the San Antonio-based H.E. Butt
Grocery Co., whose H-E-B chain is the second-largest private supermarket
business in the country, after Michigan-based Meijer. On a recent Tuesday
afternoon, the aisles were packed with customers--and high-end products.
The choices can be overwhelming. Some 30 types ofapples. Twenty kinds of homemade sausage. In the beverage section
are2,300 labels of wine and 400 types of beer (plenty
of Pilsner Urquell, from the CzechRepublic, but not a Bud in
sight). The store hires special food experts called Foodies to give
cooking demonstrations and dispense recipes. Customers leave with an
average bill about twice as big as at the company's H-E-B stores. "Head-on
with Wal-Mart is adifficult
game to win," says Scott McClelland, H.E. Butt's head ofmarketing. "But we can do things the big guys can't or won't
do. Theycan't beat our price
on items they don't have."

The Central Market example is not lost on the big guys
fighting to survive in a Wal-Mart world. The supermarkets figure that
if they canput their stores
closer to shoppers and beat Wal-Mart on variety andquality, they can give the discounter its share and still prosper."There's no doubt in our minds that Wal-Mart's
going to continue togrow, but
not everyone wants to shop there," says Albertson's CEOLarry Johnston. Right now, Albertson's is the
No. 1 grocer in theDallas
market. But to stay on top, it's adding six new stores therethis year--for a total of 100--and pouring in
more than $125 millionin capital
investment over the next two years. Kroger, meanwhile, hasbegun to specialize in Signature stores, where
the shelf selection isheavily
determined by surveys mailed out to the surroundingneighborhoods before the opening. The new store
on Parker Road inDallas opened
in early April with 860 varieties of produce--includingbitter melon, Chinese long beans, and flowering
chives that the nearby Asian-American population requested. Such attention
to detail makes Merrill Lynch analyst Mark Husson, who's bullish on
the grocers, saythat Wal-Mart
will never lure away more than the fixed number ofshoppers who always shop for price. "It's like saying everyone
whoshops at Gucci ought to shop
at Old Navy."

Maybe. But consider Ann Harrell. Harrell, a Dallas
homemaker and the wife of a dentist, is exactly the kind of customer
that the grocerychains are relying
on. She buys fresh ground coffee and recycled paper products at Tom
Thumb, and likes the fresh seafood and helpful employees at her local
Albertson's. She's never shopped for groceriesat a Wal-Mart supercenter because she's unwilling to make the20-minute drive to get there. But if it opened one closer? "Oh,
sure,I'd give 'em a go. I like
to get my dollar's worth."